13. Changes in transfer prices A Aa GNP measures income for citizens in a nation, but it does not measure what people can spend. The resources available to the private sector (that is, to the part of the economy that excludes the government) are less than GNP because governments take taxes out of income. Disposable income for the private sector is equal to GNP minus total tax payments. A multinational corporation can shift its profit from one nation to another simply by changing the transfer prices assigned to transactions between subsidiaries located in the two countries. In particular, a multinational corporation based in the United States can artificially reduce the profit reported in the United States and artificially increase the profit reported in one of its foreign subsidiaries by the transfer prices on items that its U.S. firm purchases from its foreign firm. By shifting profit to its foreign subsidiaries, the U.S. multinational corporation reduces value added by its U.S. firm and increases the value added at the foreign firm. These changes do not reflect changes in productive activity in the two locations. Nevertheless, because GDP is defined as the sum of value added produced within a nation's borders, these changes in value added reduce GDP in the United States and increase GDP abroad. Changes in transfer prices do not, however, change GNP. Although the GDP in the United States has been artificially reduced, the profit that the shareholders of the multinational corporation earn from the foreign subsidiary is artificially increased by exactly the same amount. Because GNP includes both GDP (production in the United States) and income earned by U.S. citizens and companies on foreign investments, these two effects cancel out. GNP does not change. In the United States, these types of changes in transfer prices will disposable income for citizens and tax revenue for the government. The net effect for a nation will be a loss, Tax revenue for the government goes down by more than the increase in private disposable income. The difference goes to foreign governments. Suppose that the only tax imposed by the governments in Mexico and the United States is the corporate income tax If shareholders in the United States eam income on production that takes place in Mexico and production that takes place in the United States, disposable income in the United States will equal: O GNP minus tax payments to the U.S. government and the Mexican government O GNP minus tax payments to the Mexican government OGNP minus tax payments to the U.S. government True or False: If a multinational corporation based in the United States increases a transfer price and shifts profit to a subsidiary in a country with lower taxes, citizens of the foreign country will be better off because their government will have additional tax revenue that it can spend O O True False